Instead of a smooth curve, at certain FICO scores there are big jumps in the number of people with mortgages.
The reason? Rules of thumb observed by those in the mortgage industry for judging the chances a borrower will default. In the 1990's, Fannie and Freddie released research showing that about 50% of defaults are associated with borrowers who have FICO scores below 620. That happens to be where the biggest jump in the graph above takes place, suggesting that the industry looks far more kindly on a borrower with a score of 621 than a borrower with a nearly identical score of 619.
But who used this rule-of-thumb?
The economists -- Benjamin Keys, Tanmoy Mukherjee, Amit Seru, and Vikrant Vig -- assert that securitizers followed the rule in deciding whether to buy a loan from an originator. Problem is, that meant the originator then knew he didn't have to spend much time vetting someone with a FICO score above 620, since there was a good chance the loan would be securitized and off his books. For the opposite reason, the originator would be more likely to put in the proper due diligence when considering lending to a borrower with a score below 620.
What we should then see is borrowers with FICOs just above 620 defaulting more often than nearly identical borrowers with scores just below 620. And lo and behold, when the economists looked at the data, that's exactly what they found.
Case closed, right? Not quite.
In a new paper, two Harvard PhD candidates -- Ryan Bubb and Alex Kaufman -- take an academic swipe at the big boys and point out the following: Although there is a big jump in mortgages at the 620 credit score, there isn't a commensurate jump in mortgages that get securitized at that score.
Meanwhile, Tyler Cowen points to some evidence that banker pay wasn't at fault, either:
This "executive compensation" theory of the crisis is now the keystone of the conventional wisdom, having been embraced by President Obama, the leaders of France and Germany, and virtually the entire financial press. But if anyone has evidence for the executive-compensation thesis, they have yet to produce it. It's a great theory. It "makes sense"--we all know how greedy bankers are! But is it true?
The evidence that has been produced suggests that it is false.
For one thing, bankers were often compensated in stock as well as with bonuses, and the value of this stock was wiped out because of the investments in question. Richard Fuld of Lehman Brothers lost $1 billion this way; Sanford Weill of Citigroup lost half that amount. A study by René Stulz and Rüdiger Fahlenbrach[3] showed that banks with CEOs who held a lot of stock in the bank did worse than banks with CEOs who held less stock, suggesting that the bankers were simply ignorant of the risks their institutions were taking. Journalists' and insiders' books about individual banks[4] bear out this hypothesis: At Bear Stearns and Lehman Brothers, for example, the decision makers did not recognize the risks until it was too late, despite their personal investments in the banks' stock.
All of these papers suggest that the search for a villain behind the crisis will ultimately be fruitless. There are two basic narratives of what happened. The first is that bankers had bad incentives: they took massive risks because the profits were so good in the up years that it was worth the risk of the bad, or because they could pass the risks onto some other sucker, or they thought Uncle Sugar would bail them out. The other narrative is that bankers had bad information: they didn't understand the risks they were taking.
I've always preferred narrative B, because Narrative A doesn't make much sense. The CEOs of big banks lost vast sums of money, and their jobs, most of their social status, and so forth. They held onto the worst tranches of their securities, which implies they didn't know how badly they were going to blow up. Etc.
I find it vastly more plausible, if not so comforting, to believe that systems can occasionally produce bad results even if the incentives basically point in the right direction. The FICO score revolution was valuable, but we took it too far. The money sloshing around US markets disguised the problems, because people who got into trouble tapped their home equity, or in a pinch, sold the house at a tidy profit. Everyone from borrowers to regulators was getting the same bad signal, that their behavior was much less risky than it actually was.
That doesn't mean that nothing can be done. Maybe we decide we want a less complex financial system. But it won't be because there's some villain manipulating everything into ruin; rather, we may decide that there are certain kinds of risks we can trust ourselves to handle.
I'm not sure that this would work, and I'm skeptical that it's a good idea. But the more time we waste trying to figure out who did us wrong, the less quickly we will arrive at an actual solution.
You identify an aspect of the mortgage crisis that I think is pretty important but that gets little attention. Securitization is fine. I don't see any problem with it as a concept or tool. But it seems to have been done without any recognition of fundamental shift in the lender's interest. Previously, the lender's interest was in minimizing (or managing) the default rate.
With securitization, the lender's interest is in being able to resell the loan. What the borrower does once the loan is sold is not the lender's concern.
Libertarians are the new Communists. "Hey, believe us about this totally abstract political theory! It'll work out fine, trust us! And you can't just any of our claims, because it's never been tried in its purest form before." Except I think we tried Libertarianism before. In, say, the Middle Ages. In fact, I think *every* society tried Libertarianism before. In, say, Eurasia, circa 4000 B.C. It doesn't tend to work out so great, which is why every government in the history of the world has moved away from it.
But yeah. There are no villains in our current financial crisis. Except that it came so close to not happening at all. A single passage of a single bill -- allowing mortgages not to be sliced up into pieces, and not to be sold 100 times over -- would have prevented it. ...But I'm no economist. I'm sure Megan can come up with a long blog post with some slicing-and-dicing of numbers, that totally refutes this position. No doubt.
*"And you just can't refute any of our claims..."
And has anyone, EVER (besides crazy people) claimed that the two strawmen arguments that Megan brought up were the cause of the crisis? "Excessive pay for bankers was the cause of the crisis..." Who is claiming that? No one, I'd say. But Megs quotes an article that already agrees with her thesis, and then goes on to refute that article. "No, excessive pay wasn't the cause..." How bold!
Try harder, Megan. Work better.
If your argument is that "some form of libertarianism has never been tried" then how about we revert to the level of libertarianism present when the US was founded? Of course, I'm guessing that this isn't going to phase you much since the "It's never been tried!" claim is more of an excuse than an explanation about how you logically arrived at your current beliefs, but please correct me if I'm wrong there.
(There's another instance of something similar in Samuel of the old testament, a fair bit little later than 4000BC. The biblical authors seemed to be fans of minimal government. )
In fact, I think *every* society tried Libertarianism before.
Ancient civilizations were not libertarian and did not even have written laws, let alone equality before the law. Outside of the Judaic tradition, Draco seemed to have pioneered the notion of written laws.
Except that it came so close to not happening at all. A single passage of a single bill -- allowing mortgages not to be sliced up into pieces, and not to be sold 100 times over -- would have prevented it.
Lack of securitization would probably have lessened the capital available for the bubble. But you still would have had loosened restrictions on how much banks needed to hold against particular loans, mandates against 'redlining' requiring loaning to low income families, a prolonged period with low interest rates, etc.
You could have gotten investors in the housing bubble via other means, even without securitization. Heck, since many mortgage companies kept their worst tranches that suggests a problem with over-valuation brought on by continually rising interest rates that was not dependent on simple securitization.
Heck, if a large number of people anticipated the crisis, how would you have gotten the money for securitization in the first place.
You must have learned about libertarianism from a cartoon.
Let's just cover a few bases:
Libertarianism doesn't have one pure form. It's a tendency toward broad skepticism of government power. That makes it really far from feudalism and not really synonymous with anarchism. Libertarians can run the gamut from incrementally "socially liberal and fiscally conservative" to minarchist to anarcho-capitalist, with several competing schools of thought along the way.
Libertarians don't depend on historicism or even a particular social theory: they have divergent ideas about history, politics (foreign and domestic), economics, ethics and psychology.
And they needn't insist that their ideas must be tried in anything near a pure form for many of the benefits to be observed--indeed, they'll often point out how partially free economies outperform centrally planned economies.
But every bit of coercion and fraud in the system is an arrow in the libertarian's quiver. If that strikes you as unfair, maybe your own moral or political ideas need to be more comprehensive.
Most libertarian claims about the social benefits of free markets are open to refutation, and many libertarians (a great example being the economist mentioned in the post, Tyler Cowen) are perfectly open to claims of market failure.
"Except I think we tried Libertarianism before. In, say, the Middle Ages."
Iceland in the middle ages tried something that very closely resembled certain forms of anarchism, but in general libertarianism hasn't really been tried. We came close in the 1800's but then it didn't include a lot of individuals. (slavery, etc)
I'm willing to buy that the big bankers, and the majority of their employees, didn't fully understand the risks. My question is: shouldn't they have? I'm not a risk analyst, just a semi-informed layman, and it seemed to me that a case could be made at least as early as 2005 (if not before) that these markets were heading into very dangerous territory.
There were also financial firms that didn't get caught up in the hype, looked at the numbers and saw what was coming (though perhaps not expecting a meltdown as big as we experienced) and took measures to protect themselves, their customers and shareholders. They were looking at the same data everyone else was; why did the people much closer to the epicenter not see this?
"They were looking at the same data everyone else was; why did the people much closer to the epicenter not see this?"
But isn't this almost true by definition? Those that didn't move away and hence ended up at the epicenter were those that didn't see it coming.
Megan:
Of course you do. That allows you to blithely carry on without re-examining your premises.
You don't even seem to understand the third Narrative, the by far most likely Narrative. No, not some Narrative C but Narrative A-and-a-half, that there were bad incentives and bad information.
But, again, you can't accept that because whatever part of Narrative A is true demands you to re-examine and eventually abandon your precious little libertarian First Principles.
Barf. Your comment brings to mind a phrase that rhymes with "oosh mag."
A. Acknowledging bad incentives doesn't imply problems with libertarian principles, as libertarians can point persuasively to the myriad of incentives created by regulatory action and inaction working together in what was, let's face it, a very highly regulated market.
B. Assuming that free markets created the problem, why does that imply that free markets are undesirable or libertarian "first principles" flawed? Must a system be perfect to be preferable?
How does our financial crisis compare to the legacy of central command economies?
Andy:
Um. The financial system collapsed. I'm surprised you didn't hear about it. It was in all the papers.
Um. The financial system was neomercantilist, although I'm not surprised that you didn't hear about it in all the papers.
I don't read papers, because the print media is collapsing. Greedy beat reporters.
Planned economic systems have rather bigger failures. I'm surprised you didn't hear about them.
The "financial system" didn't go anywhere near collapsing. Its experienced far worse in the past, and will probably have worse in the future. It experienced a setback that set us back, financially about 6 years. (in terms of GDP, etc)
Uhm, both cited narratives could be construed to put stress on basic principles common to libertarians, so neither A nor B nor AB would get you out of that.
One inclined to psychologize might suggest that you are projecting.
Joshua:
But of course!
Pretty much any narrative, even contradictory narratives, always could be so construed. That's the way libertarians roll, doncha know. It's easy to construe vindication for abstract theories of government (or the implied theories of human nature within those theories of government) when you never have to, you know, govern.
I'm actually a mixed-economy guy as, I believe, Megan is at heart now, too. She just can't stop clutching that last blankie of certitude that adolescent theories of government so cozily provide.
When I picture you in my head, you look exactly like that guy from the bar in Good Will Hunting with the blonde ponytail. Even if you're a woman, that's what I will see every time I read one of your comments. "last blankie of certitude"?
It rhymes with whoosh tag.
andy:
Not a bad call. I'm not blond and I'm not ponytailed, but I am from Boston and for all I know I've been in that bar.
Speaking of bad incentives: The more time politicians and pundits waste trying to arrive at an actual solution, the less mileage they can get out of trying to figure out which scapegoat did us wrong.
There are two basic narratives of what happened. The first is that bankers had bad incentives: they took massive risks because the profits were so good in the up years that it was worth the risk of the bad, or because they could pass the risks onto some other sucker, or they thought Uncle Sugar would bail them out. The other narrative is that bankers had bad information: they didn't understand the risks they were taking.
But these two narratives are not necessarily in conflict. That is, it is entirely possible that "they took massive risks because the profits were so good in the up years that it was worth the risk of the bad" but that they didn't realize that was what they were doing. They thought they were geniuses (and/or that they'd the best teams of genius quants that money could buy), and that they'd figured out how to make vast sums while avoiding risk. But, in fact, they were making vast sums by opening themselves up to huge risks without realizing it.
Bottom line -- those in charge don't have to be engaged in intentionally villainous behavior in order for bad incentives to lead them into making really bad decisions and taking really bad risks.
I gotta say, that's the explanation that makes the most sense to me. I'm not sure why Megan feels that she has to frame it as an either/or proposition--it seems to me that bad information and bad incentives are pretty complimentary.
"They thought they were geniuses": exactly. And that's why the banker pay hypothesis is so important.
Note the sentence from the quote above: "Richard Fuld of Lehman Brothers lost $1 billion [in stock devaluation]." Think about that. A billion dollars. A BILLION dollars? In share value to some hired hand? If you're Richard Fuld, what does being given a billion dollars in share value tell you? I say it tells you that you are a genius, a person of rarefied ability, a person about whom the market has spoken, saying, "This is a person who sees farther than mere mortals." How many people on his staff would go to Richard Fuld and tell him his organization was heading down the drain and, if they did, to how many did he respond, "And are you worth $1 billion in stocks?"
I think the perverse incentives caused by high remuneration weren't tied to greed but instead to vanity. And while greed may be good, I don't think we can say the same about vanity.
They were looking at the same data everyone else was; why did the people much closer to the epicenter not see this?
There was an article - I think it was in the WSJ - that interviewed a bunch of guys who worked at Bear and Lehman. One of the quotes was regarding why didn't anyone speak up - the response "We weren't paid to rock the boat."
And that gets to another set of incentives. If you work for an investment bank and are a contrarian in a hot market and you win, you are a genius and are rewarded as such. If you are wrong, you leave a lot of money on the table and get fired. If you go with the flow and win, you are rewarded (though not as much as the genius contrarian), but if you lose, you lose along with lots of other people, so might keep your job (or at least have an easier time finding a job when the economy picks up). So the smart thing to do is go with the flow.
If you work for an investment bank and are a contrarian in a hot market and you win, you are a genius and are rewarded as such.
Only if you can hold onto your job long enough to profit from your prescience.
At the beginning of this month, many money managers moved to cash as they were certain were we looking at a market correction. As of now, their hasn't been a correction. But, ever day the market moves up and those money managers remain in cash, the gap between their performance and that of the market grows. Every day their boss sees them lagging the market, they move closer to getting fired.
I fear that at this point, rehashing the story again will not teach us anything we don't already know or change any minds.
What we should be focusing on is regulation reform. It took no time at all to regulate two line items that amount to less than 1% of the problem (executive pay & corporate travel/entertainment), but actual regulation of the derivatives market is still "proposed." Queued up behind health care reform, I guess...
FWIW, the last I saw of them, the proposed changes do require mortgage writers to retain a certain percentage of their loans on their own books, which should help fix the no-barriers-to-entry problem that led to bad incentives for small-time lenders. And they're talking about centrally clearing derivatives products, which is a necessary but not sufficient step toward controlling those markets. Personally, I'm waiting for a market share cap (a la the 10% cap on retail deposits). Not enough people understand that "too big to fail" is really "too dominant to fail." If ten companies each had 10% of AIG's problems, we wouldn't be in nearly the mess we're in now.
I prefer the phrase "too big to fail is too big to exist".
I'd also like to see more regulation of credit default swaps. In the end they set up the same situation you have when a regional insurance company sells flood insurance. During dry years it makes lots of money, and then when the rain falls it couldn't possibly cover all obligations.
"when the rain falls it couldn't possibly cover all obligations"
Is there any evidence that this was true for CDS? The Lehman CDS were all settled with no problem.
The problems with CDS were more with transparency - there was no way for outsiders to measure the open interest, as opposed to the counter-trades that were used to close positions. That's what led some to argue that there was some crazy amount of claims that couldn't possibly be paid off. Without more transparency, we won't be able to tell when there truly is too much speculation.
Megan,
These articles take the blame off of financial instruments by portraying the people using these tools as plain irrational(in the economic sense). This undercuts the whole case for the neoclassical economic worldview (ie the cut regulations, market is always best, government makes the market function worse-worldview)
Okay, rather than rationally deciding whether to accept mortgages, mortgages used satisficing rules, that caused jump discontinuities in the functioning. Advertisers have known for years that people are more likely to buy something price $.99 than $1.01, but for Real-Business-Cycle models to work the people making the decisions need to not have these sorts of systematic biases or the price will be wrong.
This applies equally well to your second article, where CEOs with a stronger incentive to perform well are more ignorant of the risks their actions entail, and have performance inversely correlated with the theoretical prediction.
This is an interesting approach, Megan; abdicating responsibility by undercutting the justification for giving responsibility in the first place. If I agreed with the neoclassical view of macroeconomics, I would probably consider that throwing out the baby with the bathwater.
In your view thet are stupid and greedy, but the stupidity is more important. But this follows, if I understand you, by comparing bankers who owned many shares in their employer with those who owned fewer. But such a comparison doesn't reveal anything about the collective greed of bankers, i.e. the greedy culture in which they all immersed themselves and, indeed, selected for themselves. So my proposition is that the greed matters collectively and the stupidity individually.
Megan: The Ryan Bubb and Alex Kaufman paper does not prove (or suggest) what you and Zubin Jelveh seem to think it does.
In their model, loans are still securitized, it's just a question of whether the lender sets the cutoff first and then negotiates with the lender, or whether the securitizer sets the cutoff first and then negotiates with the lender.
When people say "securitization was the problem" they usually mean "lenders did not pay careful enough attention to credit risk because they could get the loans off their books through securitization". They do not mean "securitizers set the wrong parameters on the loans they would buy, which made lenders make bad decisions".
The paper concludes that "lenders did not pay careful enough attention to credit risk because they could get the loans off their books through securitization". At no point do Bubb and Kaufman say that if lenders had to keep loans on their books until maturity, they would make the same credit decisions that they did, which is the actual alternative to securitization.
In a new paper, two Harvard PhD candidates -- Ryan Bubb and Alex Kaufman -- take an academic swipe at the big boys and point out the following: Although there is a big jump in mortgages at the 620 credit score, there isn't a commensurate jump in mortgages that get securitized at that score.
Isn't that the problem? How does the buyer of securitized mortgages know what the risks are?
And isn't it true FNMA was hiding those risks in pursuit of social goals? People were arguing in Senate hearings before the crisis that there big risks being taken.
The only buyers of securitized mortgages are institutional investors, who are supposed to have the wherewithal to know what the risks are. These are, for the most part, not publicly traded securities (and those that are have not suffered nearly the losses as have those that are privately traded among institutions).
Sure, but are they supposed to know the risks even when the information needed to assess the risks is being deliberately hidden from them?
There's a caveat in financial auditing, which became a big deal when Phar-Mor collapsed. Auditors were being deliberately misled with a set of fake books, and correctly argued GAAP principles were not intended to uncover situations of intentional disinformation. I think a similar principle applies here.
IMO, any financial crisis worth its salt comes complete with a set of villains. They're not usually responsible for the crisis, but that doesn't mean they weren't villains. As to responsibility, I agree with the general tenor of Megan's post. The cause of this bubble, and its associated financial crisis, was the same as the cause of every bubble before it. Too much liquidity chasing too few good investments, coupled with innovation that allowed a lot of people to suspend disbelief for just long enough to get badly hurt.
I don't agree with Megan that understanding what happened is a waste of time, but I do share her concern that we'll learn the wrong lessons and take the wrong actions. Sure, punish Madoff and friends, and perhaps tweak the rules a bit in favor of better transparency. But that's it. People need to remember that as with technological innovation, sometimes financial innovation blows up. Bad things happen and people get hurt. Capitalism is like the space shuttle sitting on top of it's giant fuel tanks. In reality, we're only loosely in control of it, and that's all we can ever hope for.
The last thing we need is a redo of an Enron style backlash against innovation. And no, I'm not thinking about Sar-Box. I'm talking about electricity deregulation. Once people discovered Enron's massive energy trading fraud, the whole idea of electricity deregulation was called into question. In reality, many of Enron's innovations in energy markets were useful. They just needed debugging, mostly around transparency and risks of manipulation. Instead of simple tweaks, we saw the clock on deregulation get rolled back a decade or more.
My biggest fear in all this is that once again, the innovation baby will get thrown out in the bathwater as government bureaucrats labor under the misconception that they can tame the wonderful beast we call capitalism.
How is it not internally inconsistent to posit that bankers are paid more because "returns to knowledge/skill are higher" because the investments are "therefore riskier, because it's harder to properly understand," and then later state they didn't understand?
If they did understand the risks, they acted with willful indifference towards those risks. If they didn't, why are they getting paid at a premium?
For that matter, at what point does stupidity become a type of villainy, particularly when you're peddling your would-be knowledge/skill?
The CEOs of big banks lost vast sums of money, and their jobs, most of their social status, and so forth.
The CEOs of Goldman Sachs, Bank of America, Capital One, Morgan Stanley, Citizens Financial Group, JPMorgan Chase, American Express, Citigroup, Associated, U.S. Bancorp, Bank of New York Mellon, BB&T, Comerica, Commerce, Fifth Third, First BanCorp, Key, Northern Trust, PNC, SunTrust and Wells Fargo say hello from their executive offices.
Pretty sure they're still rich too.
Does "losing most of their social status" mean that they no longer get invited to The Atlantic's off-the-record corporate salons?
Most, if not all of the CEO's you mentioned, had huge equity stakes in their companies. So there's your loss of "vast sums of money."
You've cherry-picked the ones that didn't lose their jobs, so that's one point for you.
"Losing most of their social status" means going from "hero who saved the American economy" to "greedy, incompetent bastard who profited while Rome burned." Ken Lewis was Banker of the Year in 2008, and lost his chairmanship in 2009 (and many are calling for his outright firing and/or prosecution). I'd say that's a pretty significant "loss of social status."
Not that I'm suggesting a telethon for these guys, but I think Megan's point was that these guys had no incentive to do this on purpose - it was just as bad (if not worse) for them as it was for anyone else, relatively speaking. "Relatively speaking," of course, being the key term there...
I have to say,even though my blood group is AB(+), that the evident narrative is BA(- - -).
The bankers had inadequate information; and were never going to have all the potentially available information because information is costly. Thats B.
The bank decision makers were given incentivesto get and use little more than that class of information which increased the odds of a short term profit. Thats A.
B tells us we are always going to be at risk of finacial crises. A tells us something of how the the liklihood of crisis became acute this time round.
The minus factor is that the crisis blew like it did becase the authorities did not force the banks to recapitalise adequately. Everyone knew after Bear Stearns went down that the banks collectively were short of capital and were not willing to raise it on the markets' terms. Where there was a need for decisive action, there was a Congress unprepared for anything except a vacation; a President who did not understand; and a British Government (the people who finally acted in October) apparently in the grip of dithering paralysis.
The second problem here is, who is this "we"? Is it the government? The bankers? The regulators? The problem, it seems to me, is that "we" - pretty much the whole of society - misjudged the level of risk we were taking and our ability to distribute it in order to minimize its impacts. This is of all of a piece with the Fed trying to minimize inflation, maximize employment and let the air out of housing and securities bubbles without popping them: We keep looking for solutions where up will no longer be up, down will no longer be down and "this time" really is different. It's not going to happen.
The only "solution" is to understand that while we are able to do new and incredible things with each passing year, we are not able to fundamentally change human nature or the laws of physics. This means that we are going to make stupid mistakes that we can't see coming and we are going to pay the price. The biggest of these mistakes, and an increasingly common one, is believing that through government regulation, mathematical modeling or whatever panacea you prefer, we can create a system where there is solid upside potential if it works but no one gets hurt if it doesn't.
Just to follow up on my earlier thought: I'm not saying we should stop looking for "solutions," just that when we do find them they aren't actually going to make things perfect and only time will tell whether they make things better or worse. That said, thank God for our stupidity. Blowing trillions of dollars we don't have may not be prudent or practical, but we get to enjoy lots of cool stuff until the bill comes due. You hear a lot of advice about only investing in things you understand, not buying a house you can't afford, setting aside six months of income instead of going month to month on credit, etc. It's a great idea, if you think that one-wage-earner, one-car families living in Leavittowns and saving up for a television set of their very own represents the very best the lower middle class dare ever aspire to. But thankfully, today we have higher expectations and aspirations and different definitions of affluence than the people who grew up during the Great Depression.
The biggest risk we face today, and the one that makes we wary of "solutions," is that ,in our effort to get things under control, we will bring too much into the government sphere with the unintended consequence that financial innovation is focused on steady profits for the banks via regulatory capture, rather than looking for ever newer and stupider ways to generate the kind of capital necessary to extend our prosperity - or the illusion of it - that allows the poor man of 2009 luxuries unimaginable to the richest man of 1909.
No "villains'? The most generous reading of this episode says that there are many villains, so many in fact that it would be difficult to prosecute even a small percentage. What I hear being said is that "mistakes were made" (blogspeak for 'crimes were committed'?) but no actual person or corporate entity actually made them. Of course there are villains (by which I assume you mean some who rightfully should be charged under the appropriate statutes). The fraud at the loan origination level was such a pervasive aspect of the financial crisis as to beg for the prosecution of thousands. Check out the September issue of Harper's, http://www.harpers.org/archive/2009/09/0082630
where they excerpt an affidavit by Elizabeth Jacobson, a former loan officer at a Maryland branch of Wells Fargo. In it she details the intentional targeting of African Americans in Maryland for high-interest subprime mortgages. That complicity belies the usual ranting about "getting mortgages you can't afford". Multiply that by hundreds of cities where subprime mortgages have devastated the housing markets and you begin to see villains in every Washington Mutual and Countrywide office. And THAT criminality was induced by the structuring of incentives by investment firms further upstream. No villains? I say too many to count is a more accurate assessment.
In an age when the average income in America is $50,000 (an amount that wouldn't even make a decent bonus on Wall Street), bankers are paid handsomely for their intelligence, education and ability to sniff out a good business deal. And yet, despite their income, education and intelligence, the bankers ended up with a load of assets worth far less than nothing on their books. Assets that were in fact "toxic."
You cannot get paid what Wall Street bankers get paid then rely on the "stupid" defense when your business falls apart. Are the Ivy MBA programs claiming these people for their own? Are they proud to have educated the men who were too ignorant to see the risk behind bundling up all those NINJA/no-doc loans?
Our financial system didn't produce a "bad" result. It produced a catastrophic result. Surely bankers share some of the responsibility for the crisis.
The solution we have now, propping up failed financial institutions with large infusions of federal money, is not sustainable - nor is it capitalism any more. Bankers aren't necessarily "villains" - but because they work for companies now "too big to fail," they're no longer accountable for their actions - they know the feds will bail them out. That's a bad way to run a business - especially a business essential to prevent the collapse of our economy.
Megan, this makes as good a case for increasing and/or reforming regulation as I've heard. In the absence of bad actors or villains, the problem itself must therefore have been systemic. In other words, if this is a case where no one acted inappropriately (or, if that's too generous, where no one acted otherwise than they could have reasonably been expected to act), then we can't take an "enforce the laws already on the books" approach here -- we need new laws if we're to prevent it from happening again.
I realize there's a natural libertarian distaste for regulation, but there's also a natural libertarian distaste for moral hazard. The financial industry, as we've heard over and over the past year, is connected to and affects every other industry in fundamental ways, which is why we had to bail it out. (The reverse is why we shouldn't have bailed out the auto industry -- it doesn't provide the underpinnings of every other industry.)
Consequently, an argument for a more boring but more stable financial system, so we ensure the availability of capital for other industries, is not unreasonable from a libertarian point of view.
[Last line of last paragraph dropped accidently. Was supposed to be...]
Especially if, when they break it, we own it.
Interesting article, Megan (sorry that I misspelled your name in the last post, hadn't had my coffee). It's hard to find much in life or nature that has so much discontinuity at a single point.
As for bank management incentives, I agree that many were acting against their own self-interest, considering the degree to which their compensation was in equity awards. However, from what I've read, it certainly sounds like there were a lot of almost-top management (and of course, traders) who earned gargantuan sums of cash bonuses. If the average corporate proxy statement is any guide, 90% of all the stock options and awards go to the very few at the top (including directors). Even it top management unwittingly created a corporate architecture that promoted excessive risk-taking, it's hard for me to come to the conclusion that short-term incentives wasn't a really big part of the melt-down.
If what Megan is proposing is true (and I think she's correct), then it basically means that these crises can be neither predicted nor prevented. You can prevent the last one, but not the one the experts don't expect.
In which case, the only thing you can do is to try and structure so that you will be able to weather the crisis. Since that requires sub-optimal returns, you cannot expect individuals to do so (given that 95% of the time we're not in crisis and thus they'll fall behind their peers and get fired).
I'd say Megan is arguing (if inadvertently) for massive government intervention in every area of human endeavor where bad unexpected outcomes could affect us all.
It seems the only logical choice is to have the government dictate that no investment bank may have enough of their investments in any particular vehicle that the unexpected failure could imperil the bank.
Of course bank income will plummet, but that's the cost that must be paid for protection against events that the consensus of economists (the best source that the banks have) said could not happen (okay, said was so unlikely to happen that it would be foolish to prepare against it). (And no, a few oddballs like Roubini don't count if there arguments were so weak that they were unable to persuade the majority of economists.)
Likewise in agriculture. We cannot afford to have the vast majority of our agriculture using any one specific technique that could fail catastrophically. Government should mandate that a variety of techniques, crops, etc. that ensure that we survive an unpredicted failure. Of course the drop in agricultural productivity can be expected to massively increase prices.
Or, we could choose a few villains, hang 'em, and continue our current path without examining the fact that innovation in anything critical leads naturally to homogeneity of techniques that could destroy us in the next crisis that the experts say couldn't happen.
And since the USA is the biggest leader of innovation by far, does that make the USA the biggest existential threat to civilization (while making us all much wealthier in the meantime) :-)
What Megan is saying is not true, because the Harvard paper she references does not say that securitization was not the problem, it just said that the securitization model was a lenders-first one, not a securitizers first one.
In the absence of securitization (loans held on the books until maturity, the traditional approach) there would have been responsible, and economically valuable, credit analysis as common sense (and the Harvard paper) would suggest.
That was funny, but you're skipping a bunch of points along the way, there.
1) Agriculture, autos, high-tech, and the rest are not like banking and finance. Large companies in those areas don't need to be bailed out when they fail in order to protect the economy as a whole. This is why many people, Megan included, were for the bank bailouts but against the auto bailouts.
2) Consequently, it's reasonable to treat the Finance industry differently than you treat other industries. I'll leave it up to people better versed in finance than me to outline the details, but I remember reading them when the crisis was happening. It involved regulating investment banks like commercial banks, tightening capital requirements, etc.
Large companies in those areas don't need to be bailed out when they fail in order to protect the economy as a whole.
The companies might not, but the God help us all if, due to homogeneous agricultural policies, we lost an entire wheat crop or corn crop (remember, these policies are homogeneous across most of the world, not just the USA). It would make the financial crisis look like small potatoes. Once again, innovation (that all but some loose cannon experts approve of) could come back to destroy us.
So, do we limit innovation in any vital industry? And can you limit innovation without massive governmental interference?
If we ever actually lost the whole crop - something which has never once in history actually happened on a large scale - I think we'd be past the point of "God help us", given that it'd probably have been divine intervention that got us into the mess in the first place.
I'm not opposed to heterogeneity(though I will point out that the multitude of different crops we eat does greatly reduce our dependence on any one, even one as common as wheat or corn), but I'd suggest that you might do well to make your doomsday scenario a bit more reasonable.
An addendum - I meant "lose the whole crop" literally. Obviously, we've had bad years before, but equally obviously, those bad years haven't resulted in famine in the developed world for a good 150 years or so. We have immense food stockpiles and the ability to produce a fairly dramatic surplus in relatively short order if we ever started paying farmers to produce more instead of less. It'd take a fairly unprecedented disaster to break down those safeguards, so I assume that's what you're suggesting. If all you mean is an ordinary bad year, you'll pardon me if I don't start stocking up on canned goods.
Indeed, I'd agree that "lose the whole crop" is pretty much inconceivable. Then again, so was the financial crisis.
In fact, I'd say there are proportionally more agricultural experts crying out about the danger of our current policies having an apocalyptic ending than there were professional economists crying out about the impending doom of the banks.
No, I'd say the analogy holds. And if we did end up with an agricultural disaster (which *I* think is almost inconceivable, but then I listen to the general consensus of experts), we'd be doing exactly the same thing - looking for the greedy agribusiness guys who got rich (on the left), combined with the obvious government interference that's got to be found by those on the right...
Which is all a long way of saying that critical disasters have happened, and will continue to happen. They'll be far worse as communication and interconnectedness grows, and they'll be even worse beyond that because the pace of adoption of innovation is so high that if an innovation doesn't explode in your face in 5 years, then just about everyone is using it.
But the alternative, protecting yourself against the 'impossible', is pretty much impossible. So, we just have to live with it and try and survive the consequences. Just like we did with this crisis and just like we'll do with future ones.
Financial crises seem to happen about once a decade, depending on how severe you qualify as a "crisis". A year with zero food production has never happened in the 10,000 years we've been practicing agriculture. The reason people discounted the possibility of a financial crisis was essentially ego, the same feeling of invincibility that leads to a 17 year old driving home drunk - "Yeah, it could happen, but not to me". The reason I discount the possibility of a crop failure on the level you suggest is that it is literally inconceivable, absent side effects of some far larger disaster that'd kill us all anyways(e.g., a massive meteor strike).
I will grant that you're right about the likely reactions - that's pretty much how people would react to it happening, in the bizarre case where it actually did. Well, until the sort of people who like arguing about that stuff got eaten, anyways. But the sort of "experts" who talk about how we'll all starve to death sound like a bunch of Paul Ehrlich wannabes to me.
If we ever actually lost the whole crop
Well, I think the Irish potato famine fits the bill quite nicely. (I'm talking about massive unexpected loss of a single crop, not all different crops failing simultaneously.) With mono-crop culture, losing all our wheat or almost all of our corn is a pretty big disaster. And there are some experts who are crying doom about it, so I don't think it's asteroid-hit level unlikelihood.
As to how unlikely, I haven't a clue. I'll trust the experts and assume that it can't happen... Except...
There was a huge drawdown in world grain stocks from about 1998-2006
Honeybee hives are emptying everywhere. Bats are dying by the million due to fungus. Rust is threatening the wheat crop over huge stretches. And yet, most of the threatened famine (and all of the huge price gains - how many even remember $11/bushel wheat?) dissapated with the global recession.
Agricultural threats are real, but realisteic assessments of them are very detail dependent. Please, please, please don't let Megan get any closer to agriculture than the occasional bad recipe post.
The Irish potato famine was a genuine disaster, but to my understanding a lot of the blame for it is political. Even at the height of it, Ireland was a net exporter of food, because tariffs and subsidies made it more profitable to sell food to people not experiencing a famine than to people who were. If British agricultural policy had been geared towards making sure a million of their people didn't starve to death, then the potato famine wouldn't have been a big deal. We've had a whole lot of crop failures over the years, but the ones that spill over into actual famine are generally the fault of idiotic laws, not bad harvests. For that matter, the same dynamic has been true longer than you might think - I remember seeing a study once that said that even as far back as the Middle Ages, famines only happened when governments let them happen.
Just out of curiosity, what do people who say that "capitalism doesn't work" or "markets are not a good way to allocate resources" believe that we should do instead?
I'm not a "capitalism doesn't work" kind of guy, but capitalism has serious limitations and it often fails. We should recognize that capitalism is imperfect and capable of being terrible, and that government is imperfect and capable of being terrible. We should be skeptical of people with too much faith in either and accept that we should always be situated in place where many think we're on a slippery slope toward too much capitalism and others think we're on a slippery slope toward socialism.
"Markets" don't exist as an entity all their own.
People exist. Millions of people making decisions about what to buy, what to sell, what work to do, where to go, when to go...this is a "market" and it cannot "fail".
Sometimes, some people make bad decisions and they end up losing themselves and their investors a bunch of money. This is not a "market" failure, this is a "people" failure.
That the owners of the bad decisions wish to blame it on the "market," to spread the blame and cushion the blow says more about those people than it does about the "market".
Come on. Really.
These guys did the high finance equivalent of a $40k worker getting a $250K house, a $30k car and racking up credit card debt and then crying, "They approved my loans! I figured I must be able to afford all this if they approved it! I was even able to get 'no payment for a year' deals and two interest-only mortgages to avoid PMI on my house. I was just using the system they way it's intended."
Bad signals?
It's stupid on its face. The borrower is to blame for their poor decisions and the lender is responsible for their stupidity. Maybe they didn't understand the details of their loans but it's obvious that they can't afford it and that it's too good to be true.
I generally agree with this post. Stupidity is almost always the most likely answer.
I do believe there are structures in place which currently incentivize stupid behavior, however. It seems more and more that it's just not a good idea to have publicly traded investment banks. I'd much they went back to partnerships. I would place my own investment account with a partnership from now on when I could. At least you know they're just as screwed as you are if they muck things up. That's what I call having our interests aligned.
Megan made some really basic mistakes here, and I'm kind of surprised about it. Let's go through them.
(1) Regarding securitizations, focusing on FICO ignores that the worst loans were not subprimes, but were Alt-A's and subprimes that adopted Alt-A characteristics. And it ignores that the heart and soul of this crisis was that securitizers created the demand for those loans, because securitizers needed those exotic loans to create their exotic assets (which eventually became toxic assets). The crisis was not about loans below a certain FICO v. loans above a certain FICO. The crisis was much more about interest-only loans, zero-percent down mortgages, 120% loans, option ARMs, etc. And those were Alt-A loans, i.e., loans for folks with high FICOs, and then those characteristics migrated to subprimes in the middle of the bubble. But subprimes never would've been a problem if they didn't incorporate Alt-A characteristics, and once they did, they simply became the first to get hit because you were adding subprime on top of Alt-A.
(2) "There are two basic narratives of what happened. The first is that bankers had bad incentives: they took massive risks because the profits were so good in the up years that it was worth the risk of the bad, or because they could pass the risks onto some other sucker, or they thought Uncle Sugar would bail them out. The other narrative is that bankers had bad information: they didn't understand the risks they were taking."
There is at least a third narrative out there: Bankers (and regulators and ratings agencies and borrowers and so on) had all the information they needed, but they were really, really, really, really, really stupid (I'm not being facetious). Everyone said that there hadn't been a nationwide real estate crash since the 1930s. But they decided to ignore that there had never been an eight-plus year period (1998-2006) during which nationwide real estate prices went up 10% or almost 10% every single year, particularly given that the historical return of real estate is inflation (maybe inflation plus one percent). They also decided to ignore that various indicators demonstrated that real estate was wildly over valued (e.g., cost-to-own v. cost-to-rent). And they decided to ignore that a large part of the MBSs and CDOs were not collateralized by mortgages originated nationwide, but on mortgages in Caly, Nevada, Arizona, Florida, etc, i.e., even if we haven't had a nationwide crash since the 1930s, there were plenty of regional crashes, and lots of the risk was focused in particular regions. Let's face it, there was just a lot of stupidity out there.
(3) With all due respect, it's flat out ridiculous to point to Dick Fuld or Sandy Weil. Losing $1 billion means a lot (duh), but it's not the end of the world when you're still worth hundreds of millions (which I believe Fuld is). The issue is how are incentives affecting junior, mid-level, and even senior investment bankers who are the ones primarily responsible for pulling the trigger on deals. Of course Fuld and Weil didn't know the risks of what was going on, their job, believe it or not, wasn't to get that deep into the weeds (you could argue, though, that it was their job to know from a big picture perspective how much of the firm's risks were tied up in real estate and that they should've recognized the risks of a real estate correction). But it was the job of the junior folks, and the reality is that (a) you get bonuses for making big dough but don't have to pay it back if you lose the next year and (b) stock options don't provide nearly as good incentives as restricted stock options.
Megan is usually spot on, but I'm really surprised by the really basic mistakes she made here.
Cogent and fact-filled. Thank you, Janice.
with regards to 3)
even at a junior level -- much of "bonus" compensation was paid in the form of restricted stock that had a multi-year lock up associated with it. Anyone at the bank for more than a few years likely had a substantial portion of their net worth indexed to the performance in their employers stock.
Interestingly -- the bank that used stock as compensation the most? Bear Stearns.
The idea that a bunch of bank traders would knowingly and willingly put the value of their substantial stock holdings at risk to chase a $250k cash bonus doesnt hold water.
Bubbles always seem so obvious after they pop -- yet for every person citing data why the mortgage fueled real estate run-up was a bubble -- there was someone equally credentialed and respected giving a data supported rationale why the top of the market hadnt been reached yet.
I think it would take a lot of research to obtain the ratio of cash to options/stock awarded as bonuses. One report stated that the top 5 "Wall Street Banks" (by which I assume they mean investment banks) paid $40 billion in bonuses in 2007, of which half was cash and half was stock or options. With a little SEC-sniffing, I've read enough commercial bank 10K proxy statements to note that top management and directors accounted for a lot of the option grants.
So, at this point, I have to assume that the claim that stock/options were a substantial portion of incentivizing bonuses is anecdotal. Since this is a core component of the arguments above, it seems like a good thing to get real data (and links, please) on.
Bankers (and regulators and ratings agencies and borrowers and so on) had all the information they needed, but they were really, really, really, really, really stupid (I'm not being facetious).
Again, who were the experts that the bankers should have been listening to? The broad consensus of economists was certainly that we were not on the tip of a crisis. Of course, there were a few dissenters, but they obviously incapable of making a case that persuaded their fellow experts.
To be honest, one tends to think of CEOs that ignore the experts they hired (and the expert's generally held opinions) as fools that should be fired as soon as possible. After all, that's why you hire experts.
It would be like the president of a hospital not trusting medical consensus.
A bubble, almost by definition, is about mob rule. So your defense, in effect, is to say that almost everyone was part of the mob, so no one who was part of the mob is to be blamed for being part of the mob (since almost everyone else was part of the mob). We don't accept that excuse when a mob lynches a black man, and we shouldn't accept that excuse when a mob buys up MBSs and CDOs despite all the data indicating that's a very, very bad idea.
I remember the dot.com bubble like it was yesterday. And I remember that the financial press overwhelmingly (as in 80-90% of it) said this time was different. It doesn't matter if these companies don't have profits, don't have a business model, don't have a path to getting profits. This time is just different. A small minority (10-20%) said p/e ratios and price-to-book are way out of whack. A crash is coming. And they also said, ummm, not having a business model or a path to profits is not a good thing, this time is not different. A crash is coming.
The fact that so many investors (both retail and institutional) abdicated reason and facts in favor of the hype doesn't change the fact that if you were sober and thought things through, it was clear we were in a bubble. Or to put it another way, a majority of people were really, really, really, really, really, really, really, really, really stupid. That, after all, is why we get bubbles.
Now it also might have been stupid to try to profit off of the bubble. As the saying goes, don't overestimate your ability to stay solvent longer than the market's ability to stay irrational. (Although, of course, some did make quite a bit of dough betting on the real estate crash). But that doesn't mean that it wasn't stupid to bet on the bubble. I simply do not accept the excuse that because everyone was doing it, you can abdicate responsibility and accountability. Or maybe my point is better stated this way: given the substantial amount of evidence of human fallibility, it's really stupid to base decisions on what everyone else is doing instead of what the data says. Unless, of course, incentives induce you to base decisions on what everyone else is doing instead of what the data says. Which is the crux of why Megan is so, so, so wrong.
despite all the data indicating that's a very, very bad idea.
Again, 20-20 hindsight. Very few thought it was a bad idea before the crash, and those who thought it was a bad idea couldn't make strong enough arguments to persuade the economists (who aren't raking in big bucks).
More than that, the CEO has to persuade the *shareholders* that a crash is coming, otherwise they fire him for leaving money on the table (or more accurately, he doesn't get promoted to become CEO).
In other words, you can't be CEO of a large public institution *without* following the crowd, at least if your intuition is going to lead to large losses relative to your competitors in the name of caution.
And yes, to my mind that means that CEOs are generally way overpaid, but then it's the share-holders and the customers that determine that, not me. If they're willing to pay him jillions of dollars, it's their money, not mine. (At least until we have to bail them out.)
Now having said that, I think there's a good argument that industries that are too critical to fail must be regulated so that they cannot fail except under the most extraordinary of circumstances (nuclear war, etc. :-)). However, as a society, we must be prepared to face the enormous cost of protecting ourselves against unlikely possibilities. And that I don't see happening anytime soon.
Well, if they aren't the great financial forecasters and guardians of investors that they claim to be, then why the hell are they being paid hundreds of millions of dollars? Look, they failed royally-and screwed all of us in the process. For that epic fail, they get to be rescued by the federal government and to award themselves bonuses this year- and that's all?
You guys are certainly forgiving-towards rich bankers. Towards poor people-not so much.
then why the hell are they being paid hundreds of millions of dollars?
Because the stock holders and the customers are willing to pay them that. Remember compensation (and prices in general) only depend on what people are willing to pay, not on any intrinsic worth. These may (are supposed to) have some correlation, although as I get older and more cynical, it seems to be less often than I like. However, who am I to tell other people what to pay?
Now that we've bailed out the banks, I do think we have a say. But I don't think that changing the pay scale will make any difference unless the bankers are shockingly unprofessional. They're job is to make their bank the most money they can when controlling for risk. They were trying to do it before, and they'll try to do it afterward. After all, that's there job.
As for regulating so we don't end up on the hook - I've made by opinion clear in previous posts in this topic. There's a substantial argument to be made for doing so, but I don't think human nature will let us drop our standard of living to protect ourselves against perils that the experts believe are unlikely to happen (which is exactly what happened here).
Tom West,
With all due respect, we're talking in circles. You: everyone was doing it, so it was OK, and criticisms are 20/20 hindsight. Me: no, the data was clear, they should've been listening to the data, not others. You: but everyone was doing it, so any criticism is 20/20 hindsight. Me: no, the data pointing in one direction means criticisms are not 20/20 hindsight, and you really can hold bankers culpable for being really, really, really stupid.
As for the second part of your post, you just admitted that the incentives drive decisions away from risk management and towards short term thinking (you get fired if you don't do it because everyone else is doing it and making money, so you do it and don't worry about when things fall apart 3 years from now because you can just say, "hey, everyone made the same mistake, don't blame me!"). In fact, there's a substantial amount of literature that discusses that incentives such as risk of getting terminated specifically cause a mob mentality problem, and short term rather than long term thinking, because you can just point to what everyone else is doing. So, the only solution, of course, is more government and regulation.
the data pointing in one direction means criticisms are not 20/20 hindsight,
Okay, if 10,000 economists looked at the data, and only 50 of them said we've got a problem, then I *am* going to claim that no, it wasn't in the data in a manner that could be used for a useful prediction. (Especially if a number of the dissenters are 'perma-bears')
Remember, this wasn't just the bankers who had an incentive to ignore bad news in the data, this included pretty much everyone who had every incentive to pull out if they saw a problem coming. Those who are biased towards conservatism (pension funds, etc.) didn't see it coming. (I know that indeed some investors had moved to cash, but I haven't seen anything that indicated that a greater than usual percentage of investors were in cash. In other words, as always, some people got lucky.)
Honestly, if you are claiming that essentially almost every economist in the world is catastrophically incompetent, then that's a pretty serious problem for modern society. Especially since regulation needs to be based on... the government economists who's job it is to protect us from these crises who also could not see the obvious danger.
Now, I think it's reasonable to say that that in the light of the evidence, we can conclude that science of economics is *incapable* of making predictions of this nature, but I don't think it's reasonable to state that all economists are incompetent.
(As an aside, are there any other fields where you feel there is obvious data that every expert in the field is misreading? We might both be able to make a few bucks :-))
It was a bubble. Values were based off of rising prices, not ability to repay loans or income generating potential. The reward structures, accounting rules, tax rules and too trusting investors only made the problem worse.
Yes, Nelson, but there are bubbles and there are bubbles. If you believe Krugman (and most here don't), this wasn't your Mother's bubble, this was a small delta away from the kind that cause Depression 2.0. The Tulip Boom wasn't an existential threat to the financial system of the Free World, for example.
Hence, the calls to regulate, hence the libertarian/conservative/uber-free-market impulse to disprove the need for regulation.
If distorted incentives were a part of the problem, eliminating them is part of the solution. Seems like a good idea to establish the facts before positing a solution, maybe.
There's nothing anti-libertarian about recognizing that people will attempt to further their own interests, not necessarily those they're supposed to be working for.
The government guarantees deposits, therefore depositors ignore risks when selecting banks. Shareholders can only see short term profits, so that's what they demand. CEOs of financial institutions get paid a lot to make big risks with other peoples' money, so that's what they do. Home buyers can make a lot of profit with a minimal investment and if it doesn't work out they can walk away (plus they get a pretty nifty tax break on the deal).
Incentives do matter. I don't really mind the libertarian philosophy of letting people fail in order to teach them a lesson. The school of hard knocks is harsh but effective. But I also don't mind the government making regulations that minimize well known problems such as the principal-agent one. It's better overall if the regulations and regulators are good and correct. Unfortunately it's equally likely that the regulations will cause more harm than good (such as tax incentives that encourage common people to gamble on the housing market, or limited liability corporate structures that encourage CEOs to take big risks with other peoples' money).
Megan:
You know I'm a fan of yours, but how can you write something like this after your last post saying ACORN is corrupt and incompetent? I think you've got your ideological blinders on, something you rightly accuse liberals of.
ACORN gets millions of dollars from the federal gov't. Last number I heard was 53 million over their entire 30+ year lifespan. Meanwhile, the banking industry has sucked a trillion or two out of the government in the last two years, but your conclusion is that it's not really their fault?
I'm sympathetic to the argument that there's no villians to be found in this crisis, that the economy was dealt a perfect storm and the bankers just happened to be the highest-paid scapegoats available. But not when this argument comes right after you fault an organization of activists operating on a shoestring budget for failing to weed out the losers on their payroll.
Let's be clear- I don't like bankers because I'm a liberal. I fundamentally mistrust rich people who have different political goals than I do, and I'm not getting anywhere by trying to convince myself or you toherwise. I've got a few reasons why ACORN deserves the benefit of the doubt here- but don't you think you're stepping too far in the opposite direction? You've just written a post about how the highest paid fuckups in the history of the world should be let off the hook because they weren't as omniscient as they bragged they were, but an organization that had a few members who gave bad tax advice to a fictional pimp is a sign of deep, institutional rot.
"And DOWN goes Frazier..."
For the third frickin' time. I tell you, if hypocrisy was money, Megan and her conservative commenters would be billionaires.
This is a refreshingly honest comment and it really helps me better understand the visceral hatred toward folks in the financial sector. It's just a normal case the left getting reliably worked up by perceived economic injustice against the have-nots at the hands of the haves. It's about as predictable as the outrage that folks on the right often feel when they encounter non-conformance or perceived weakness of character.
As I said in my earlier comment, every crisis has its villains and this one is no different. If we're patient, we'll eventually get to see a trial or two and maybe even a few frog-walks off to the pen.
But no matter who we convict, or what regulations we create, human nature and crowd psychology will conspire to give us another bubble eventually, and then another, and then another. Show me a society where savings is free to search out investment opportunity and I'll show you a society that regularly experiences manias and panics. Bubbles are in our societal DNA and it's foolhardy to think they can be moderated beyond some small measures to possibly mitigate their collateral damage.
As was already deconstructed in the previous ACORN thread, that figure only includes direct Federal grants to ACORN itself. It does not include the total funding absorbed by the complete umbrella of ACORN's subsidiaries, funds which sometimes included state matching grants. And the objection was not that ACORN was receiving public money at all, but rather the fact that multiple offices in different parts of the country were ready and willing to give advice on how to manipulate the tax code (federal crime) to conceal a pimped (illegal in all states) prostitution (illegal everywhere except Nevada) scheme employing 13yo foreign nationals (highly illegal just about everywhere).
Hence, any continuing effort to compare general objections to ACORN's continued existence with bipartisan-sponsored efforts to salvage a grotesquely overextended economy in which some eight-figure number of US citizens had some first- or second-order link of culpability will be taken as evidence that the arguer is dangerously unserious.
I'm simultaneously amused and horrified when I hear the statement that the financial people who made huge amounts of money didn't understand the risks inherent in the system they were operating.
Let me run that again: these people made huge sums of money. Money that they pulled out of the system and got to keep. In some cases there was a lot of money in addition to what the got that they didn't actually get, for example, stock that didn't cash out.
From these people's perspective there was no risk. At least not in the sense that ordinary people making less than huge sums can fathom.
Real people think of risk as the possibility of losing something of -real- value. The only real risk the top-enders faced was not of losing something it was only of not getting more.
One other thing. Please, please, please take every opportunity to stomp all over and extinguish any hint of a spark of the idea that everyone involved in the financial industry (and what an insidious, damaging, and damning phrase that it) is a rational actor. This great pillar of modern economics is patently and obviously untrue, and it's sole value has been in its use as a justification for the creation of the systems that channel enormous wealth out of the economy into the coffers of the few privileged operators of the systems.
Dameon pretty much wins the thread. A national grass roots organization is supposed to have its head cut off because a few of its employees screw up (and get fired). However, bankers, who get paid hundreds of millions of dollara because they are financial experts, lose trillions of dollars and f**k up the WORLD economy and it's "Oh well, boys will be boys?". Not only that, but "Here's a trillion dollars of tax payer money to help you to fix this problem which you, the Masters of Universe, created" .
What's astonishing is that anyone of these upper level managers even has a job any more. Shouldn't captalism be all about punishing economic failure? If they had lost their jobs, gone bankrupt and been forced to repay the investors whose funds they so recklessly sqaundered, then I would say " OK".
But even now, they are busily paying themselves lavish bonuses. What for? Why , for being rescued by that evil federal government the commenters here despise!
I tell you, its like Bizarro world on this blog. According to this blog, Its not the bankers massive breach of their fiduciary duties that's the danger: it's whether the federal government will actually do anything hold them accountable . Amazing .
My eyes popped pretty vigorously when I saw the headline as well. To draw a comparison, if there was a rash of deaths, on the scale of 1,000 to 10,000 because of widespread failure on the part of doctors to make an obvious diagnosis, we wouldn't be arguing "Well, everyone makes mistakes". Each time I got a house I paid everyone involved really well. And by really well I mean two weeks pay at median income. My assumption is that I was paying these actors for their expertise and the requirement by banks and govt. that somebody smarter than me about finance and real estate would double check all the info.
I worked off the assumption that somebody, somewhere, was doing due diligence in checking my fitness and the relative fitness of the property the bank was about to become 90% co-owner of. You know, for the thousands I was paying them.
If this money was used to pay for the expertise, why do we need these guys? To stand in the road of commerce and demand a toll? And if it was, then why are a LOT more of them not being stripped of licenses? Oh. Right, because they and their employers have lobbyists, lawyers, and resources to protect them.
This:
Together with this:
Is just more evidence of the EMH being dead, dead, dead. And if price signaling was so out of whack in this particular area - something it seems everyone is agreed upon - then there really isn't any justification for invoking the 'free market' then, is there?
Thanks to the libertarians for admitting that, finally. At long last.
then there really isn't any justification for invoking the 'free market' then, is there?
Well, I think that the untouched free-markets are about as successful as direct democracy (i.e. a disaster).
But I also think that history has shown that societies that don't have a reasonably strong basis in either democracy or markets don't do all that well either.
While I don't think pay is necessarily linked with "intrinsic worth", I don't think there's a fairer method than allowing the democracy of the market - - you're being paid what what *somebody* thinks you're worth, and if it's their money... (Of course, I have little trouble with fairly high tax brackets either.)
I prefer a system that supplements those that are being paid less than a socially optimal amount. The US has a reasonable system (EITC?) that I think my own country (Canada) could emulate.
Again, once the government has bailed out the banks, the rules do change. (Not that I think that changing compensation will change banker behaviour, but at least the government has a moral right to interfere.)
This is a refreshingly honest comment and it really helps me better understand the visceral hatred certain conservatives have toward anything they label 'liberal'. That conservatives would hate the DFH's for being right yet again is entirely predictable. Remember folks, for a certain type of conservative, it's not about being right. It's about winning.
The problem with this is that anyone who agrees with a liberal is also accused of being one. Skeptical of the justifications for the invasion of Iraq? You must be - gasp! - a liberal. Agree with the overwhelming majority of professionals that subprime loans to minorities weren't the cause of the financial meltdown? You must be a liberal. Think global warming is anthropogenic? You must be a liberal.
Megan does waaaaay to much of this "if a liberal says it, it must be wrong. And if you agree with it, you must be a liberal." That's Rush Limbaugh and Glen Beck demagoguery.
The failure of heavily regulated and government influenced financial markets is not an indictment of capitalism or free markets. It's an indictment of THIS particular market/industry. The solution isn't necessarily more regulation, it's most likely different regulation. Rather than look at how we can pile more and more regulations on the financial system, maybe we should step back and look at the existing regulatory system and look for ways to make it better (maybe through more or maybe through less).
Assuming that there was a real need to bail out the banks and financial institutions to protect the world's economy from total collapse, I'd rather some of the money go towards offensively high bonuses for undeserving executives than have the government step in and mandate compensation levels. While the former is bad, I believe the latter would be worse and would lead to a never-ending government control of financial institutions. Let's get the system back on its feet and then look at changing the regulations to prevent the preventable parts from happening again...
Bad Incentives?
More like different incentives. The money managers were in a win vs win-big situation, the customers, the investors, were in a lose-win situation. That plus a bit of exuberance, and the money managers made deals (bets) that they wouldn't have made if they were exposed to the same risk.
Many of the investment houses had also recently changed from partnerships to limited-liability corporations, somewhat insulating themselves from loss.
Megan,
Why does it have to be either A or B? Why not both?
Government definitely provided the wrong incentives while at the same time creating a housing bubble that seemed to offer limitless profits at low risk. Meanwhile, the artificially low interest rates drove bond rates down so low that investment dollars flowed toward mortgages and mortgage-backed securities.
The bankers surely did not understand the implications of all their financial machinations, but they did understand that one financial product (MBSs) was performing great while competing products were sucking wind.
Hrmm, again, seems the Austrians are correct!
You don't need "back actors" for a recession/depression. You merely need widespread malinvestment. The recession then is supposed to clear the malinvestments and the people who made mistakes and we can start over again, doing things the right way.
I'm seeing a lot of "blame the victim" here...
No villains? Billions loaned to people (including illegal aliens) who had an infinitesimal chance of completing a 20 year mortgage contract; that was faultless? In what universe? What part of "that was a set-up" isn't obvious to you?
Five Trillion in mutual fund dollars withdrawn on one day, 9 September 2008, right before a highly contested presidential election; that was, what? a coincidence? I'm not sure how naive your average readers is, but I know when I've been had.
The "investor net" was full of sucker fish, and the (full in the name of your favorite hedge-fund manager here) of the world just hauled that catch in, yeah no villains, right! and I have a bridge to sell you.